TECHNICAL COMPETITIVE ADVANTAGE: A STUDY IN THE ENGINEERING SERVICES INDUSTRY CHARLES A. MALOVRH

Transcription

1 TECHNICAL COMPETITIVE ADVANTAGE: A STUDY IN THE ENGINEERING SERVICES INDUSTRY by CHARLES A. MALOVRH B.C.E., University of Minnesota, 1972 S.M., Massachusetts Institute of Technology, 1974 Submitted to the Sloan School of Management and the School of Engineering in Partial Fulfillment of the Requirements for the Degree of Master of Science in the Management of Technology at the Massachusetts Institute of Technology June 1987 Charles A. Malovrh 1987 The author hereby grants to MIT permission to reproduce and to distribute copies of the thesis document in whole or in part. Signature of Author: Sloan S 9 hool of Management and Department of Civil Engineriig, May 8, 1987 Certified by: Certified by: Accepted by: \' K ofessor, Management Thesis Supervisor Fred Moaven&adeih Professor, Civil Engineering Thesis Reader Ole S. Madsen Chairman, Departmental Committee on Graduate Students

2 TECHNICAL COMPETITIVE ADVANTAGE: A STUDY IN THE ENGINEERING SERVICES INDUSTRY by CHARLES A. MALOVRH ABSTRACT Submitted to the Sloan School of Management and the School of Engineering in Partial Fulfillment of the Requirements for the Degree of Master of Science in the Management of Technology The management of technology has been recently emerging as a recognized interdiscipline field. This has occurred largely as a result of the ever increasing importance of technology in virtually every industry. At the heart of its importance is the competitive advantage that can be obtained through technical innovation. This thesis investigates the nature of technical competitive advantage (TCA) in that segment of the engineering services industry engaged in the design of petrochemical plants. Fundamental elements related to the development and sustaining of TCA are presented in a conceptual framework applicable to any industry. The focus on a single industry segment facilitates a deeper study of the essential features of TCA, but also illuminates elements of broader applicability. Elements identified as central to obtaining and sustaining TCA are compared to relevant features of two case studies of the role of engineering firms in new process development. The basic concept of "knowhow" is identified as the most critical element of sustainable TCA. Technical advantage is derived from superior knowhow in specific process engineering technologies which enables innovative solutions to complex engineering problems. This ability is manifested in improved designs of engineered equipment and systems and the commercialization of new processes evolving principally from manufacturers' basic R&D efforts. The primary measure of the existence of TCA is recent past performance of the engineering firm. This can be either in terms of effective solutions to complex engineering problems associated with new process development or improvements to existing processes or in terms of the physical performance of recently engineered plants.

3 With intense competition in the industry, firms seeking technical competitive advantage focus on one or more market niches but leadership is seldom secure. The continuing technical competition results in a general pattern of one firm gaining advantage, reflected by a significant portion of contract awards, followed by a shift in leadership to another firm as its evolving technical capabilities are demonstrated by their recent performance. Loss of TCA seldom results in exit from competition, but rather a continuation of the cycle by ongoing technical development efforts. Thesis Supervisor: Title: Reader: Title: Eric von Hippel Profesor of Management Fred Moavenzadeh Professor of Civil Engineering

4 Acknowledgements I wish to express my sincere appreciation to Professor von Hippel for his guidance in the development of this thesis. His active assistance and constructive comments served to make this effort a valuable learning experience. Also of great value was the cooperation of all individuals in the industry with whom I have had the opportunity to discuss the basic concepts of this thesis. Their insightful comments and experienced opinions contributed greatly to this study. Finally, I wish to acknowledge the indirect contributions of all faculty members of the Sloan School and the School of Engineering with whom I have had the pleasure of being associated with throughout the Management of Technology Program.

5 Table of Contents Title A bstract... 2 Acknowledgem ents Table of Contents Introduction Background and Central Issues Petrochemicals and Productions Processes Structure of the Industry Central Issues of Investigation Technical Competitive Advantage Constituents of TCA How TCA is Obtained How TCA is Protected How TCA is Lost What Happens if TCA is Lost Summary of TCA Case Studies of Petrochemical Process Innovation The Gulf/SWEC TRC Process The Mobil/Badger Ethylbenzene Process Comparisons of Case Studies to the TCA Model Conclusions References Appendix: Interview s

6 1.0 Introduction The ever increasing intensity of both domestic and foreign competition in virtually all industries has focussed a significant degree of effort towards the understanding of the broad issues of "sustainable competitive advantage." Notable among many works in this area is that of Michael Porter (Ref. 1). This thesis will examine the role of technology as a significant factor in the establishment of competitive advantage. Clearly this is a broad subject in and of itself with many elements of varying degrees of importance in differing industries. In order to enable a reasonably detailed study, a single industry segment is studied herein. This thesis investigates the nature of technical competitive advantage (TCA) in that segment of the engineering services industry engaged in the design of petrochemical plants. While specific findings are directly applicable to this industry segment, they are presented in a general framework applicable to any industry. In this manner, findings can be compared or contrasted with corresponding characteristics of TCA in other areas, although that is beyond the scope of this study. Chapter 2 provides background information on the petrochemical industry. A brief summary of its origins and current structure are presented as a backdrop for subsequent discussions of engineering firms. Given this setting, the specific issues to be studied and the framework to be employed are presented. The fundamental elements and issues of TCA in the subject industry segment are presented and discussed in Chapter 3. The ideas and findings presented are based on personal experience in engineering (although not 6

7 specifically in process plant design), interviews with personnel in a number of engineering firms, and literature reviews (primarily trade journals). Section 4 presents two case studies of the development of petrochemical process innovations in which engineering firms provided the primary technical leadership. Features of these cases are then reviewed in terms of the evidence they provide in support of the model of TCA developed in Chapter 2. An overall summary and conclusions are provided in Chapter 5 and a record of interviews is contained in the Appendix.

8 2.0 Background and Central Issues 2.1 Petrochemicals and Production Processes Petrochemicals are chemical compounds (principally organic) produced by chemical reactions from hydrocarbon feedstocks obtained from petroleum (crude oil or natural gas). The petroleum industry produces hydrocarbon fuels, lubricants, and petrochemical feedstocks. The petrochemical industry is less precisely defined but fundamentally is that sector of the chemical industry engaged in the production of large-scale quantities of basic organic chemicals and their derivatives. The petrochemical industry is quantitatively small compared to the petroleum industry given that less than 5% of petroleum produced is used as petrochemical feedstock. However, with the value of petrochemical products often being more than ten times that of petroleum products, annual sales of petrochemicals are on the order of $100B. The family of petrochemicals is related in a hierarchical manner. Each compound is produced by a chemical reaction which adds, removes, or restructures elements of one or more "upstream" chemicals. Although there is no precise definition, petrochemicals are often categorized into three groups: basic hydrocarbons, petrochemical intermediates, and end products. The "end products" are not further altered chemically but are often either formulated with other materials as differentiated chemicals for specific industrial or consumer applications, or used by other industries for fabricating their products. The predominant end products are polymers used to manufacture plastic materials, synthetic fibers, and synthetic elastomers. Other end products are used in fertilizers, pesticides, adhesives, detergents, paints, pharmaceuticals and many other applications.

9 Figure 2.1 presents an abbreviated illustration of the relationship of the major petrochemicals and their categorization. The two major groups of basic hydrocarbons are olefins (primarily ethylene and propylene) and aromatics (benzene, xylene, and toluene). Olefins plants can use a variety of feedstocks including ethane and propane from natural gas, refinery gases, and naphtha, a light distillate. Ethylene is the predominant petrochemical building block with annual production running nearly 40 billion pounds while propylene, a coproduct of olefins plants, is produced at a rate of approximately 18 billion pounds per year. Butadiene is also produced primarily as a co-product of olefins plants. Aromatics are produced primarily from naphtha with benzene produced in the largest quantity at approximately 16 billion pounds per year. The fundamental processes used in petrochemical plants have been largely adopted from refinery practice. In fact, large scale petrochemical plants resemble refineries although they are often more complex. The two major functional elements of a plant are the reactor and downstream separation and extraction units. The reactor is the heart of the operation, wherein the synthesized petrochemical compound is created by means of pyrolosis and/or catalytic reactions. In pyrolosis reactors, high temperatures alone cause the cleaving or "cracking" of carbon-carbon and carbon-hydrogen bonds and the subsequent recombining of molecules into different hydrocarbon compounds. The principal application of pyrolosis reactors is in olefins plants with reactors operating in the range of to F. In other applications, as in the production of vinyl chloride, the process is somewhat more complicated with the ethylene dichloride feed flowing through catalyst filled tubes during pyrolosis.

10 Basic Petrochemical Petrochemical Product Hydrocarbons Intermediates End Products Uses Ethylene... Polyethylene... Film or Sheet j..ethylene dichloride...vinyl Chloride...Polyvinyl chloride... Pipe or Sheet.-Ethyl benzene...styrene monomer..polystyrene... Packaging i.ethylene oxide...ethylene glycol Antifreeze S..Acetaldehyde... Acetic Acid...Vinyl acetate...polyvinyl acetate... Paints and adhesives Propylene... Polypropylene... Injection molded plastics -,-Cumene......Phenol... Phenolic resins... Laminates and adhesives.isopropanol..-:.-acetone... Methyl methacrylate... Transparent products.a crylonitrile A crylic fibers.propylene oxide... Various plastics Butadiene...Styrene butadiene rubber... Synthetic elastomer.. Vinyl butadiene...synthetic elastomer L.Nitrile rubber... Synthetic elastomer Benzene......Cyclohexane... Nylon fibers Xylene...Terephthalic acid/dimethyl terephthalate...polyethylene terephthalate...polyester fibers T olu ne... G asoline additive Selected Major Petrochemicals Figure 2.1

11 Most petrochemicals intermediates and many end products are produced by catalytic processes. These include hydrogenation or dehydrogenation (addition or removal of hydrogen), alkylation or dealkylation (addition or removal of paraffin radicals) as well as oxidation and chlorination. The key to these processes is the identification or development of effective catalysts. Also, the process oftens becomes increasingly complex as the product becomes further removed from its origins and also more chemically complex. Downstream operations are fundamentally simpler, generally involving physical processes alone rather than chemical reactions. Separation of the petrochemical products(s) from the reactor outflow is normally performed by one or more of the following processes. * Distillation: separation based on differences in volatility of components in the mixture. * Absorption: separation by contacting gases with a liquid solvent. * Liquid-Liquid Extraction: separation by selectively dissolving one of the components in an immiscible solvent. * Adsorption: separation by concentration of a component on the surface of a porous solid. Major objectives of the entire design process, beyond production of the product itself, are to achieve the highest possible yield from the feed materials and to obtain high purities. Additionally, most processes are energy intensive and energy efficiency has become increasingly important, primarily in terms of heat recovery throughout the process.

12 2.2 Structure of the Industry As is the case with most technological developments, commercial development of petrochemicals significantly lagged scientific understanding of the phenomena. Not long after the real onset of the petroleum industry in the 1850s, it was recognized that petroleum could be used as a base material for the manufacturing of chemicals. The first petrochemical plants were not built until the early 1900s, however, and larger scale plants were not built until the 1930s. Prior to this time, the chemical industry relied primarily on coal as its base material. The earliest petrochemical plants used hydrocarbon feedstocks that were incidental by-products of oil and natural gas refineries. As demand increased, special processes were developed to provide the required quantities and purities of feedstocks for downstream operations. These developments brought the petroleum and chemical companies into close association in this new and rapidly growing industry. Oil companies integrated forward into the realm of petrochemicals in order to create added value from their operations. Chemical companies were reoriented from coal to petroleum as their raw material and integrated backward into the production of petrochemical intermediates and basic hydrocarbons from petroleum feedstocks. As a result, today's petrochemical industry could generally be characterized as being comprised of the downstream operations of "petroleum companies" (usually by subsidiaries) and the upstream operations of "chemical companies." Following is a more specific characterization of the current structure of the industry.

13 As a starting point, a simple model depicting the relationship between suppliers, manufacturers, and users is shown in Figure 2.2. Manufacturers include virtually all major chemical companies. In fact, only 10% of the 100 largest U.S. chemical companies do not manufacture basic or intermediate petrochemicals. Suppliers are comprised of two groups: those supplying raw materials and those providing for the physical plant. Users include all the industries which produce finished goods manufactured from petrochemical end products. As a first elaboration on the industry model, it is essential to recognize two major overlaps between suppliers, manufacturers, and users. First, as mentioned previously, all major petroleum companies have integrated forward into the production of petrochemicals, thus eliminating a distinct division between raw material suppliers and manufacturers. Second, most major chemical companies also produce differentiated chemical formulations and fabricated products from petrochemicals, thereby becoming users as well as manufacturers. These characteristics are presented in Figure 2.3. Finally, and central to this thesis, is the role of the petrochemical plant design firm. Due to the complexity and scale of petrochemical plants, the engineer/constructor plays a key role in the commercialization of new processes and the efficient and improved design of plants employing established processes. In general, plant design can be thought of in terms of two distinct elements: process design and detailed engineering. For an established production process the process design package is typically prepared by an engineering firm and in its simplest terms includes a process flow diagram which presents schematically the sequential process 13

14 Manufacturers Firms Supplying Raw Material or Equipment Firms Producing Petrochemicals Basic Industry Model Figure 2.2 Firms Using Petrochemicals Manufacturers Equipment Suppliers Petroleum Companies Chemical Companies Petroleum Companies Chemical Companies Allied Products Firms Industry Model with Overlaps Figure 2.3

15 operations and process equipment specifications, all of which must be tailored to the unique characteristics of each plant. Preparation of the process design package is the technological heart of the plant design. Even for plants using the same fundamental process, both feedstock and product specifications may vary and by-products may also be utilized in varying ways. The degree of technical expertise provided by the firm developing the process design package will significantly influence the final optimization of all design parameters. Preceding preparation of the eventual commercial process design packages is the actual development of the process itself. Process development (including basic research, analytical development and bench scale testing) most commonly originates from R&D by manufactures, although there are many cases of active involvement by engineering firms, as will be discussed later. Detailed engineering includes engineering calculations and analyses leading to the preparation of fabrication and construction drawings for structural, mechanical, electrical and controls systems and the preparation of procurement, fabrication, and installation specifications. Detailed engineering is virtually always performed by engineering firms. Exceptions are in the cases of plant modifications which may be handled in varying degrees by the engineering staff of the chemical company or in a limited number of cases where the largest chemical companies have a sufficient engineering staff to handle a complete plant. The addition of the elements of plant and process design to the industry model is shown in Figure 2.4. As described above, process design overlaps between the chemical companies and engineering firms.

16 Engineering Firms Manufacturers - Petroleum Co.'s - Chemical Co.'s Pet Petrochemical Manufacturers uct Firms ers m Co.'s l Co.'s i Petrochemical Industry Model Figure 2.4

17 There are hundreds of chemical companies operating in the U.S. today. Table 2.1 identifies the top twenty in total chemical sales and their sales from plastics products and synthetic fibers. Also shown is their ethylene plant capacities. Several points are worth noting with respect to the data in this table. 1. Five of the top ten and nine of the top twenty firms are petroleum companies. Not coincidentally, these include the eight largest petroleum companies. 2. The relatively lower sales of plastics and fibers by the petroleum companies bears out the fact that their concentration is primarily on the basic hydrocarbons and intermediates. ARCO, with its separate Polymers Division, is a major plastics producer, however. 3. Ethylene capacity is a good indication of the degree of upstream integration of the chemical companies. Six of the eleven have major ethylene plants. A large number of firms offer engineering services in the area of petrochemical plant design. These include companies spanning a wide range of sizes from over $5B to under $50MM in annual revenues. Due to the diversity of operations of many of these firms and the large differences in the sizes of individual projects, it is difficult to specifically rank order them in terms of "market share" in the petrochemical industry. Table 2.2, however, identifies several of the important competitors and provides an indication of their market size, although the percent of business in petrochemicals varies greatly. Additional discussion in terms of their bases of competition is contained in Chapter 5.

18 Petrochemical Manufacturers Petroleum Companies Chemical Companies Annual Sales ($B)(1) All Plastics Synthetic Chemicals & Resins Fibers Ethylene Capacity (bil#/yr)(2) Exxon Chevron Shell Amoco Occidental Phillips Mobil ARCo Texaco Dupont Dow Union Carbide Monsanto Celanese Hercules Eastman USS Chemicals Rohm & Haas Allied Ethyl (1) 1980 data (Ref. 2) but indicative of relative structure (2) 1986 data (Ref. 3). Major Petrochemical Producers Table 2.1

19 Representative Firms Engaging in Process Plant Design Total 1986 Design Related Engineering Firm Contracts ($MM) (1) The Parsons Corp Bechtel Group Inc M.W. Kellog Co Fluor Daniel Brown & Root Inc Lummus Crest Inc Jacobs Engineering Group, Inc Foster Wheeler Corp Stone & Webster Engineering Corp Sante Fe Brown, Inc Barnard and Burk Group, Inc John Brown E&C Inc The Badger Co., Inc. <100. (1)Includes design only and design-construct contracts in all business segments (Ref. 4). Table 2.2

20 2.3 Central Issues of Investigation As stated in the introduction, the objective of this thesis is to investigate the nature of technical competitive advantage (TCA) in a single industry (engineering services) and a specific segment within it (petrochemical plant design). At the same time, it is desired to do so within a generally applicable framework. Such a framework is provided by the following central questions: 1. What constitutes technical competitive advantage? 2. How is technical competitive advantage obtained? 3. How is technical competitive advantage protected? 4. How is technical competitive advantage lost? 5. What happens if technical competitive advantage is lost? Proposed answers to each of these questions will be presented and discussed in Chapter 3 as they specifically relate to the subject industry segment. In doing so, distinction will be drawn between the essential elements of TCA and other factors which may be valuable prerequisites to competing, but in and of themselves provide no distinguishable advantage. Also, although much of the discussion will inherently be qualitative, objectively measurable elements will be provided to the extent possible.

21 3.0 Technical Competitive Advantage in the Design of Petrochemical Plants This chapter presents a discussion of the fundamental elements of technical competitive advantage (TCA) in the subject industry segment within the framework presented in Section 2.3. The extent to which findings may be unique to the industry segment studied or of more general applicability will be discussed in Chapter Constituents of Technical Competitive Advantage The concept of technical competitive advantage may call to mind a wealth of images. Marketing literature of engineering firms is filled with descriptions of attributes such as: * full range of engineering services, worldwide capability * years of experience, more than _ projects completed * best in the business, excellence and superior quality * large projects on time and within budget * computer aided engineering and design * able to answer special needs of customer * experienced people, skilled personnel, creative engineering * innovative problem solving, creative engineering * proprietary technology, acquired patents, licenses and knowhow * process evaluation, process improvement, process commercialization Several of these characteristics are indicative of technical competitive advantage while others, although important, are more indicative of competitiveness based on factors other than technical leadership. Also, without

22 getting at the substance underlying these features, they may in fact represent no more than the fundamental prerequisites to being in the business and as such provide essentially no distinguishable competitive advantage. This section will identify and discuss the underlying attributes which are considered to be the basic constituents of TCA. Again, that is not to downplay the importance of cost related and other commercial bases for competition, but the distinction is essential. Although most would agree that it goes virtually without saying, the absolute essence of TCA is technically sound and creative engineering personnel. This may be implicit in any characterization of TCA, but is of such importance as to warrant unique identification. Whereas the quality of personnel is important in any industry, it is especially so in engineering services, where the capabilities of the personnel are the heart of the capabilities of the firm. To emphasize the point, consider the concept of the diffusion of technology. Although other mechanisms may be more common, none are more effective than the movement of key personnel within whose body of knowledge the key elements of advanced technology are embodied. But all engineers are "talented." The distinction of consequence is that between the ability to perform basic (not meaning simplistic) engineering and design tasks and the ability to develop creative solutions by means of associative processes drawing from a depth and breadth of basic technical knowledge. Any firm which reaches a position of technical leadership will have such personnel at the forefront. Firms that do not have as creative a staff will be hard pressed to compete on a technical basis. Given the prerequisite of a talented and creative engineering staff, perhaps 22

23 the functionally most significant element of TCA is the possession of state of the art capabilities (superior "knowhow") in one or more of the basic engineering technologies applicable to process plant design. In this era of high-tech electronics and biotechnology, "state of the art" may at first bring to mind rapidly evolving technologies such as these and seem at first thought inconsistent with "basic engineering." The key, however, is that all technologies are evolving, regardless of the rate and, by definition, only a small number of firms can be said to possess or be advancing the state of the art in even the long established fields of mechanical and chemical engineering. The specific technologies of greatest value can be characterized as "enabling" technologies, i.e., those which enable innovative advances in the design of engineered process equipment and systems. The distinction is intentionally made between such engineering technologies and those more closely related to basic science. The role of even the most technology oriented engineering firm is ultimately to design reliable and economic commercial facilities. Although an understanding of the process chemistry is essential, the engineering firm is not in competition with the manufacturer, and maximum advantage is derived from a state of the art position in the basic enabling engineering technologies. The scope of relevant technologies does change, however, and those firms which are leading the way in terms of application of new technologies or which are able to quickly adapt will gain technical competitive advantage. Two brief examples are given below which will illustrate the point without going into technical detail. The first relates to leading positions in well established technologies while the second relates to adopting an emerging technology.

24 First, consider the technology of fluidized bed reactors. Feedstocks are mixed with a catalyst and the reaction occurs while the mixture is flowing through a vessel at the required pressure and temperature. Beyond the chemistry of the reaction, the basic technology requires knowledge of heat transfer, fluid dynamics, and solids circulation. All engineering firms competing for projects employing such a process will have capabilities in these areas. However, those firms with the most sophisticated expertise and analytical tools in these areas - coupled with creative engineers - will derive technical competitive advantage from their ability to solve design problems in innovative ways unlikely to be arrived at by the competition. As another example, consider the case of computerized control systems. Clearly there was a time when any application of computerized systems was far from being an established technology. It was not long, however, until the benefits of computerized process controls were evident to all. Although this would be considered an established technology today, those firms who led the way of introduction or who continue to advance the state of the art in terms of sophistication of applications today certainly had or have a technical competitive advantage as a result. It is noted that the advantage came not from research on computer technology, per se, but from the pursuit of creative engineering applications. The second potential element of TCA is the possession of superior knowhow in a competitive production process. Whereas the first element of TCA is of potentially broad applicability, the second relates to unique expertise in all facets of production of a particular petrochemical. These differing forms of expertise are often closely related but offer advantages of different natures. Firms with superior knowhow in a given process have a technical advantage in 24

25 competing for associated plant design awards. The degree of advantage will be directly related to the degree of competitiveness of the process. In contrast, firms with superior knowhow in a particular area of process technology are more likely to be sought to solve unique problems, evaluate new processes, and potentially participate in new process development. Finally, a third element of technical competitive advantage is or can be the possession of rights to a superior process technology. Although "superior technology" ultimately implies one offering a commercial advantage, its technical features would include one or more of the following: forms: * higher product yield or purity * greater feedstock flexibility * fewer process steps * greater energy efficiency * less "down time" Possession of rights to such a process technology may take one of several * sole or joint ownership of the process patent * exclusive or restrictive rights to market the process (owned party) by another Possession could also be in the form of a superior but unpatented this is unlikely. process, but The critical element here, in terms of TCA, is not so much the form of possession, but that the process is indeed superior or at least strongly competitive. While rights to other, even many, patented processes does in fact

26 allow competition in those markets, if the process is not technically superior, no TCA is associated with such process rights. In summary, the fundamental constituents of technical competitive advantage are: * Superior "knowhow" in a specific area of process technology * Superior "knowhow" in a competitive production process * Rights to a competitive production process The essence of the first two elements of TCA, both related to knowhow, is quite subjective and as such must have some associated objective means of assessment. The means by which such advantage is demonstrated by the engineering firm (and evaluated by the potential client) is by evidence of recent successful project performance. Although it takes time to develop and establish a reputation for technology leadership, "what have you done lately?" is the real test of a firm's knowhow at any point in time. In considering any contract bids, the client, among other considerations, will assess the credence of technical claims by evaluating actual results of equivalent or analogous recent projects. Such efforts will always be emphasized by the engineering firm and can be confirmed by discussions with prior clients. If the award at hand requires the solution of novel engineering problems, evidence of successful experience employing that area of expertise is the demonstration that such knowhow exists. Even if the firm does not have explicitly applicable experience, evidence of other complex and generally analogous problem solving can serve to demonstrate the underlying knowhow. The third element of TCA, rights to a competitive process, is inherently

27 less subjective, but again is demonstrated by recent performance. A client can compare process claims made by competitors for the design of a new plant against performance of their latest projects in quantitative terms such as product yield and purity, energy consumption, and other operating costs. In all cases, recent relevant projects can be viewed as the engineering firm's "product" and as such provides the basis of comparison of relative technical advantage. 3.2 How Technical Competitive Advantage is Obtained As discussed in section 3.1, the heart of technical competitive advantage is a highly skilled and creative engineering staff. primarily by selective recruitment of talent. This is obviously achieved Movement of key personnel between firms does not appear to be common in this industry and most new employees come directly from college or via a relatively early move after a first job. Having the right personnel alone, however, is not sufficient. In order to take full advantage of the unique strengths of individuals, the firm must foster a reasonably innovative atmosphere. Given the intense competition in the industry today and the associated small profit margins which are prevailing, tight cost control and relatively rigid structure are the norm. Under these conditions, it is no small challenge to create an atmosphere of reasonable creative freedom, but one which must be attempted if innovation is to be achieved. Development of state of the art technology capabilities is fundamentally an on-going in-house process characterized by "success breeding success." Although it is a simple concept, the most effective means of increasing expertise is via actual experience and the better the firm is technically, the more likely it is 27

28 to obtain technically challenging projects. In somewhat of a limiting extension of this concept, a firm with an established position of technology leadership becomes a leading competitor for the commercialization of a new process developed by a chemical company. Having this opportunity both enables the firm to increase its technical expertise by application of existing skills to inherently new design problems and also results in the ability to claim unique experience when competing for subsequent project awards. Given the benefits of a commercialization project, competitive firms will strongly seek such opportunities. In many respects this is analogous to the "lead user" concept presented by von Hippel (Ref. 5). If a firm can anticipate such developments and establish early mechanisms for technical assistance or participation, the stage will be set to play a dominant role in future implementation of the new process. Other means also exist for increasing technology strengths, particularly from outside sources. For example, the M.W. Kellog Co. has arrangements with engineering software firms through which it acts as a testing ground. Through this process, Kellog is able to both influence software developments and also obtain advance access to improved products. Similarly, the Badger Co. has a collaborative arrangement with an artificial intelligence company. Together they are working on AI routines that could be used in conjunction with Badger's process simulation software for troubleshooting of plant operational problems. University research would also appear to be a potential source of advanced technology, but this does not appear to be the case. Apparently such research is considered to be too far removed from near term applicability to warrant active 28

29 pursuit. (The validity of this concept could be an interesting subject to investigate.) Obtaining rights to a superior process may or may not stem from an established position of technical leadership. If the process has been developed solely by a chemical company a number of factors come to play in establishing arrangements with engineering contractors. The first issue is whether or not to grant exclusive marketing rights. Doing so reduces the number of ensuing legal complications but also may limit the potential for future sales of the process, particularly in terms of the global market. If exclusive or restricted marketing rights are not granted, no significant TCA is derived specifically from rights to use the process, although TCA may still be obtained by exploiting the opportunity to expand technical expertise. If exclusive rights to the process are to be awarded, they will not necessarily go to the current technology leader. Another firm with a broader market presence or one offering better commercial considerations may also be a strong contender. Existing technology leadership will be of relatively increased value, however, if the new process entails a significant departure from traditional designs. Process rights will accrue directly to the engineering firm if they have been actual party to the process development. Depending on the degree of participation, the result could range from exclusive access to the process to a joint ownership and sharing of royalties. Clearly this situation is most likely to develop for a firm that has the state of the art technology to bring to the development process.

30 Sole development of a patented process by an engineering firm may also occur, but is the exception. Such cases can typically trace their origins to earlier collaboration with the manufacturer, but for a variety of reasons resulted in subsequent spin-off of independent efforts. In most such cases the basic chemistry of the process is well understood and process improvements were derived primarily from significant advances in equipment design and system configuration. Although these situations are of significant value to the engineering firm, as mentioned, such opportunities are infrequent. Given the establishment of a talented and creative staff, the process of obtaining TCA can be summarized as a largely interdependent combination of the following mechanisms. * Experience * Research and development * Acquisition The opportunity to increase knowhow and develop technical advances in conjunction with the experience of ongoing design projects is perhaps the most common means of increasing TCA. Most effective is the experience and knowhow that can be obtained from a new process commercialization project. Whether experience has in fact led to TCA can be evidenced by the degree to which a firm's technical capabilities have actually increased over time. In-house R&D appears to be most effective when focussed on those basic and emerging engineering technologies which will enable innovative advances in the design of engineered process equipment and systems. Basic research in process chemistry is infrequently the domain of an engineering firm for two basic reasons. First, the direction of such research is best dictated by market needs 30

31 and the engineering firm is one step removed from first hand knowledge of such requirements. Second, with revenues derived fundamentally from the sale of services (manifested in drawings, specifications, and technical reports) as opposed to a manufactured product, there is not a separate cash flow from which to fund such research. Therefore, venturing into new areas is best done in concert with the needs of a client company. Opportunities of this nature may arise from problems developing in operating plants or from R&D projects originating within the client's organization. Acquisition of rights to a new process will not necessarily be granted to the current technology leader, but such a position may significantly increase the likelihood. Possession of such rights are stressed in a firms' marketing efforts and generally known of through industry publications (Ref. 6, 7). 3.3 How Technical Competitive Advantage is Protected The petrochemical industry is a mature one and by many current standards the rate of technical change is comparatively slow. Technology in any field is not static, however, and a firm that has reached a position of TCA will not automatically retain that position. Trade secrets, also commonly referred to as proprietary information, are a pervasive mechanism of guarding a firms technology. (Maintaining strict confidentiality regarding a firm's technical capabilities also protects against disclosure of areas of weakness.) Virtually all firms require all professional employees to sign non-disclosure agreements. Most visible, however, are the detailed secrecy agreements executed by multiple parties involved in the design of a new plant (which typically utilizes a licensed proprietary process). Even when entering into initial discussions with a prospective client, confidentiality 31

32 agreements must be signed before any technical details of the process are discussed. When a contract is awarded, detailed non-disclosure and non-use terms are included, typically for a period of about 15 years. Such agreements not only protect the technology, but also serve to tie future plant modifications to the original engineering contractor. Subcontract awards for major equipment items which employ proprietary technology are also covered by similar confidentiality agreements. As the technology becomes further removed from the source, e.g, goes to subcontractors, the ability to police the maintenance of confidentiality diminishes. Breaching of agreements is uncommon, however, with a strong motivation being the value of retaining a reputation for integrity. This is true at all levels, given that a tarnished reputation will result in serious consequences, not only in terms of legal liability but also in terms of prospects for future work. Also essential to protecting TCA is the common mechanism of patenting. Consistent with the fundamental role of the engineering firm, most of their patents are for equipment rather than processes. The degree to which firms file for patents is somewhat a matter of philosophy. The trend however appears to be related to the potential commercial value of the invention and the perception of the degree of competition. The greater the potential value or the likelihood of a competitive design, the more likely the firm is to patent as opposed to relying strictly on trade secrets. With respect to patent filing, innovative inventions may often occur in the form of a group of related designs or as one with separable features. In an attempt to somewhat obfuscate the integrated value, it is not uncommon to employ multiple filings for the separable elements. 32

33 A third mechanism of protecting TCA is through the terms of a process licensing agreement. As discussed earlier, TCA can be obtained by acquisition of rights to market a competitive process, the heart of the design package. The value of this form of TCA is directly related both to the degree of competitiveness of the process and also to the extent that it is protected though terms of the agreement. If a firm is able to acquire exclusive rights to market the process, an excellent degree of protection of the technical advantage has been achieved. Protection is only of value in the relatively short term, however, and sustaining TCA requires continual technical advancements. Such advancements can be made independently in each of the three elements of TCA: knowhow in a specific area of process technology or of a competitive process or rights to superior processes. No unique discussion is necessary with respect to how this is accomplished, other than observing that it is a continuing evolution of the process which originally led to the achievement of TCA, with perhaps one exception. Once a technical advantage has been gained in some area, this can be further capitalized upon by seeking out new areas of application. This could be the result of a partnership process development, a commercialization project, or in-house efforts to make improvements to established processes. It should also be emphasized that within the highly competitive environment of engineering services, the establishment of a dominating technical advantage, even in a narrow area, is not common and lesser technical advantages are often short-lived. Therefore, to assure ongoing commercial success, a firm must also establish a competitive position on other non-technical bases, e.g., breadth of engineering services, effective management systems, and generally efficient engineering practices. In other words, the value of TCA is 33

34 diminished if the firm is unable to offer a commercially competitive total engineering services package. To summarize the means of protecting and sustaining TCA, the essential mechanisms are: * Trade secrets * Patents * Licenses The degree to which trade secrets are used as a means of protection cannot be readily quantified. Their importance is evidenced, however, by the pervasive emphasis placed on guarding proprietary information, both in daily practice and by the standard practice of employing secrecy agreements with clients and contractors when proprietary technology is involved. The extent to which protection is sought by patents and licensing agreements is also difficult to rank, but their use is directly observable. In order to be effective, however, these means of protection must be accompanied by ongoing pursuit of technical advances in order to sustain or increase TCA in the long run. Strengthening of non-technical bases of competition will also leverage the value of TCA. There are two sides to this issue. A firm can never lapse if it hopes to retain TCA, but conversely, TCA if properly exploited can grow on itself. Having an established position will promote obtaining new opportunities, but failure to capitalize on the opportunities will result in the loss of TCA.

35 3.4 How Technical Competitive Advantage is Lost It has been stated that failure to sustain TCA will result in losing it. This is true because of the inevitable advances that will come from the competition. The most common means by which TCA is lost is that of evolutionary advances made by the competition. These are two sub-elements to this mechanism. In one case, the paths of technology development being followed by competitors are fundamentally similar and the one who progresses more quickly will eventually achieve a leadership position. In the second case, rather different technical approaches are being pursued, each of which will have differing ultimate limits. The firm pursuing the approach with the lower ultimate limits, even if initially gaining TCA, will unavoidably be surpassed eventually by the competing firm. Another mode of losing TCA is by means of a revolutionary, rather than evolutionary, change in technology. Examples could include radical changes in an existing process technology or emergence of an entirely new process. Such changes will of nature often originate from sources outside of the established competition. Breakthroughs in technology not originally directly related to an existing process may be transferable to other applications, resulting in a sudden shift in technology leadership. Although it is not easy to react to such a change, the firm with the greatest strength in the basic technologies will be in the best position to adapt to such a change. With existing expertise and creativity, the firm will be able to not only adapt, but also develop innovative improvements to the new technology and find additional applications. Finally, TCA may be lost through external factors related to market demand. In the extreme case, even a uniquely strong advantage in a particular process technology may be rendered of little value if demand for the product 35

36 declines significantly. Such an event could occur for technical or non-technical reasons. Technology based circumstances could include the emergence of a superior substitute product or, for an intermediate product, the development of a new process for making the end product without use of the current intermediate. Non-technology based factors could include changes in prices of raw materials or changing environmental regulations relating to the product process or its usage. Although such changes in market demand may be unavoidable, their consequences may be minimized in two ways. First, and quite obvious, is the need to be continually monitoring market changes (both technology and nontechnology driven) in order to better anticipate and prepare for the change. Second, is to maintain as competitive a technical position as possible in all basic process technologies, in order to enable a flexible response from a strong established position. The various means by which TCA can be lost can be summarized as the following: * Faster evolution by the competition. * Radical technology changes by others * Significant changes in the product market. The loss of TCA in a given area will be readily seen by a decline in a firms' presence in that market segment. Should either of the first two circumstances develop, new awards will quickly shift to the firm that offers the demonstrably superior technology. In the third case, the number of new projects will obviously diminish for all firms. The first means of losing TCA is best avoided by continued pursuit of